Accounting Forum xxx (xxxx) xxx–xxx

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Accounting Forum
journal homepage: www.elsevier.com/locate/accfor

Rethinking agency theory in developing countries: A case study of

Pakistan
⁎
Fatima Yusufa, , Amna Yousafb, Abubakr Saeedc
a
Coventry Business School, William Morris Building, Gosford St, Coventry, CV1 5DL, United Kingdom
b
Swinburne University of Technology, John St, Hawthorn, VIC, 3122, Australia
c
Department of Management Sciences, COMSATS University, Islamabad, Pakistan

A R T IC LE I N F O ABS TRA CT

Keywords: We investigate if agency theory effectively explains agency conflict in the context of a developing
Agency theory country namely, Pakistan. Utilising data from 26 semi-structured interviews, we found that in
Developing countries Pakistan, there is no variation in risk preferences of principals (minority shareholders) and agents
Board independence (majority shareholders). We also found that remuneration packages and board independence are
Board remuneration
not effective tools for governing owner managers in Pakistan. Thus, policy makers must shift
Principal-principal conflict
their focus from soft internal governance mechanisms of appropriate remuneration and board
independence. We propose for a rigorous external audit function, and appointment of in-
dependent directors and external audit firms by regulator.

1. Introduction

Agency theory has served as the most influential viewpoint in the field of corporate governance research, policy making and
practice (Aguilera & Jackson, 2003; Brennan & Solomon, 2008; Christopher, 2010; Daily, Dalton, & Cannella, 2003). Agency theory
assumes human beings as self-interested and points out conflict of interest between principal and agent (Berle & Means, 1932; Jensen
& Meckling, 1976). This conflict of interest can be aligned by either offering appropriate incentives or by monitoring agent’s activities
(Chng, Rodgers, Shih, & Song, 2012; Eisenhardt, 1989; Jensen & Murphy, 1990). Resultantly, corporate governance codes across the
world focus on aligning the interests of principals with those of the agents by devising equitable executive remuneration and ren-
dering non-executive and independent directors to be the key monitors of the actions of executive management (Cuevas-Rodríguez,
Gomez-Mejia, & Wiseman, 2012; Fama & Jensen, 1983; Fama, 1980; Feldman & Montgomery, 2015).
However, various assumptions of agency theory have been criticised and a few researchers have proposed amendments to its
theoretical underpinnings and offered alternative flexible frameworks (Cuevas-Rodríguez et al., 2012; Hendry, 2005; Lan &
Heracleous, 2010; Lubatkin, Lane, Collin, & Very, 2007). The traditional agency theory was developed for providing a basis to Anglo-
American model of corporate governance and researchers have developed and studied the assumptions of agency theory mainly in the
context of developed countries, especially the USA and UK (Matolcsy, Stokes, & Wright, 2004; Mueller, 2006; Uddin & Choudhury,
2008; Young, Peng, Ahlstrom, Bruton, & Jiang, 2008). Accordingly, corporate governance reforms focused on dealing with the
problems created by separation of ownership and control in efficient capital markets. Researchers suggest that the classical model of
agency cannot be suitably applied to markets in developing countries that are characterised by concentrated ownership structure,
strong family control and weak governance context (Abdullah, Evans, Fraser, & Tsalavoutas, 2015; Dharwadkar, George, & Brandes,

⁎
Corresponding author.
E-mail addresses: fatima.yusuf@coventry.ac.uk (F. Yusuf), ayousaf@swin.edu.au (A. Yousaf), abubakr.saeed@comsats.edu.uk (A. Saeed).

https://doi.org/10.1016/j.accfor.2018.10.002
Received 16 April 2018; Received in revised form 9 October 2018; Accepted 10 October 2018
0155-9982/ © 2018 Elsevier Ltd. All rights reserved.

Please cite this article as: Yusuf, F., Accounting Forum, https://doi.org/10.1016/j.accfor.2018.10.002
F. Yusuf et al. Accounting Forum xxx (xxxx) xxx–xxx

2000; Young et al., 2008). Despite this unsuitability, developing countries introduced internationally accepted corporate governance
reforms only because these countries need foreign aid from international funding bodies (Reed, 2002; Siddiqui, 2010). We contend
that developing countries were encouraged to implement these unsuitable governance reforms because so far, a suitable theoretical
and policy framework has not been developed owing to a lack of attention paid to this issue. The empirical evidence examining the
assumptions of agency theory is inconclusive (Bhagat & Black, 2002; Dalton, Daily, Ellstrand, & Johonson, 1998). The large body of
inconclusive evidence also signifies weakness in theoretical grounds, subsequently resulting in the development and implementation
of irrelevant and ineffective governance reforms in developing country contexts (Reed, 2002; Uddin & Choudhury, 2008). In this
paper, we critically assess the application of existing agency framework along with an examination of the existing mechanisms for
aligning interests of principals and agents in a developing country’s context. We propose amendments in certain assumptions of
classical agency model and also propose alternative mechanisms for dealing with agency conflict in this particular developing
country, that is, Pakistan.
We chose Pakistan for a case study analysis because the capital market, social and political set-up in Pakistan shows a sharp
contrast to the context of developed countries, such as the UK and USA. Pakistan is a developing country with weak law enforcement
and high levels of political corruption (Easterly, 2001; Javid & Iqbal, 2008), lack of transparency, highly volatile equity market,
dominance of family owned business groups, and strong corporate-political connections (Ashraf & Ghani, 2005; Iqbal, 2012; Islam,
2004; Muttakin, Khan, & Subramaniam, 2014; Rabelo & Vasconcelos, 2002), which are the all-encompassing characteristics of
developing countries.
We argue that although the study of agency problems between owners and managers as proposed by classical agency perspective
is important, however, developing countries primarily present a nexus of agency problem termed as principal-principal conflict
(Dharwadkar et al., 2000; La Porta, Lopez-de-Silanes, & Shleifer, 1999; Lau, 2010; Young et al., 2008). Pakistan, like many other
developing countries is characterised by high levels of ownership concentration and strong family control (Gilson, 2007). In such a
context, managers represent majority shareholders interests and in most of the cases, decision making and management roles are held
by the same individuals; that is, the controlling members (Lau, 2010; Li & Qian, 2013). Thus, agency problem in developing
countries, such as Pakistan, primarily exists between minority and majority owners (Dharwadkar et al., 2000). However, since
principal-principal model is also based on the assumptions of self-interest and risk aversion as presented in classical agency theory
(Eisenhardt, 1989) and proposes mechanisms of incentive alignment and monitoring of executive management by non-executive
directors, we extend existing literature by analysing applicability and usefulness of these assumptions in the context of Pakistan.
According to traditional agency model, the agents/managers are more risk averse than principals because of limited employment
options and a lower incentive to make additional efforts, while investors/principals are interested in investing at diverse and efficient
avenues (Eisenhardt, 1989; Faccio, Marchica, & Mura, 2011; Foss & Stea, 2014; Wiseman, Cuevas‐Rodríguez, & Gomez-Mejia, 2012;
Sauner-Leroy, 2004). Thus, according to traditional agency perspective, in markets accompanied by high level of ownership con-
centration, controlling owners and large shareholders in family firms may tend to be highly risk averse (González, Guzmán, Pombo, &
Trujillo, 2013; Zhang, 1998) as they are exposed to both the systematic and unsystematic risk of the firm. Minority shareholders, on
the other hand, face no systematic risk (Zhang, 1998) and thus they might be less risk averse. We challenge this assumption and argue
that in most of the developing countries, minority shareholders might be very small investors. Since these countries are economically
deprived, more than often, these investors might have a small amount of spare money to invest. Small investors also face the obstacles
of various entry barriers such as lack of information/literacy about markets (Reardon, Taylor, Stamoulis, Lanjouw, & Balisacan,
2008), and lack of exit options (Leeds & Sunderland, 2005). Furthermore, since the level of literacy in developing countries such as
Pakistan is very low, limited information about investment options and a lack of financial and technical literacy may further reduce
the capability of investors to diversify their investment options (Xu & Zia, 2012). Thus, these investors might not be interested in
making investments in high risk ventures, as assumed by traditional agency perspective. Thus, we contend that the assumption of risk
aversion in traditional agency theory is very simplistic and propose that there will be no differences in risk preferences of minority
shareholders and owner managers in the context of such developing countries as Pakistan. This leads us to the development of the
first research question for this study: does the assumption of risk aversion in traditional agency theory provide an appropriate lens for
explaining corporate governance in the context of a developing country such as Pakistan?
We also challenge the effectiveness of remuneration packages as a governance mechanism for resolving agency conflict in de-
veloping countries such as Pakistan. In highly concentrated capital markets having family firms, explicit compensation contracts are
either completely non-existent or even if they are drafted, remuneration is not typically linked to firm performance (Kole, 1997). In
countries with weak governance context and high levels of corruption, the nature of remuneration package also becomes an in-
effective governance mechanism owing to higher opportunities for entrenchment (Morck, Shleifer, & Vishny, 1988; Wang & Xiao,
2011). Adverse selection problem also exists in such markets as majority owners are known to hire their incompetent family members
on the board, who lack skills to run the organisation (Dharwadkar et al., 2000; Li & Qian, 2013). Thus, incompetence of the family
members might provide another explanation for why the executives in these firms accept lower or no compensation (Schulze,
Lubatkin, Dino, & Buchholtz, 2001). Thus, we propose that remuneration contract cannot work as an effective governance me-
chanism in the context of Pakistan. We further challenge monitoring of executive management through independent directors to be
an effective option for handling managerial self-dealing (Liu, Miletkov, Wei, & Yang, 2015; Yekini, Adelopo, Andrikopoulos, & Yekini,
2015) in the context of developing countries such as Pakistan. Existing research argues that in highly concentrated capital markets
with family firms, a lack of separation between ownership and control alleviates the need for appointing independent directors
(Klein, Shapiro, & Young, 2005). Owing to a strong presence of social ties and networking, independent directors, in the context of
developing countries, may also partner with owner managers and thus may not get any platform for exercising their independence
(Su, Xu, & Phan, 2007). Furthermore, since independent directors are dependent on owner managers for information so as to control

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managerial opportunism (Hendry, 2005), they may find it hard to access such information in highly concentrated capital markets
with strong family control. Thus, we contend that the mechanism of board independence might be ineffective in the context of
developing countries with high level of ownership concentration and family control (Abdullah, Mohamad, & Mokhtar, 2011) such as
Pakistan. This leads us to the development of second research question for this study: can internal mechanisms of remuneration and
monitoring work effectively in resolving agency conflict in developing country context?
This paper makes several important contributions to the exiting literature on agency theory. Firstly, contrary to existing literature,
this paper challenges an important assumption of agency theory regarding agent’s risk aversion in comparison to principal. Secondly,
it shows that governance mechanisms of board independence and monitoring do not work effectively in the context of a developing
country like Pakistan. Thirdly, this research has important policy implications. It points out that in the context of Pakistan, only an
implementation of stringent regulation on governance and audit may help in resolving agency conflict. The findings of this research
will therefore provide insights that could be applied in the investigation of other countries sharing a similar capital market structure
and institutional context. This research hence advances the agenda for carrying out in-depth research in the context of these
countries, thus examining the compatibility of agency theory based governance regulations in the institutional context of developing
countries.
The rest of the paper proceeds with an explanation of why we chose Pakistan for a case study analysis. Following on, we provide a
critical review of existing literature on agency theory, followed by the presentation of study’s research design and methodology as
well as the analysis and discussion of our findings. We conclude this paper with some implications for practice and areas for future
research.

2. Context for this research

We contend that a close analysis of board behaviour is essential for development of corporate governance theory, regulation and
practice in developing countries (Brennan & Solomon, 2008). Accordingly, in this paper, we are providing ‘interplay of theory and
observation’ of corporate governance practices in a developing country namely Pakistan (Hendry, 2005).
Pakistan was chosen for this study owing to its unique capital market, and social and political set-up which exhibits a sharp
contrast to the capital markets of developed countries. Pakistan’s institutional environment is characterised by weak law enforcement
and displays high levels of political corruption (Easterly, 2001; Javid & Iqbal, 2008). According to the Transparency International
Corruption Perception Index (2016), Pakistan was positioned at 116 from a total of 176 countries. Based on its colonial past, Pakistan
is considered a common law country, however, it exhibits the characteristics of a code law country. Common law countries focus on
providing strong legal protection to investors which results in development of strong stock markets (La Porta, Lopez-de-Silanes,
Shleifer, & Vishny, 1998; La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1997). Code-law countries, in contrast, are characterised by
weak investor protection and thus their stock markets rely heavily on debt. Pakistan, despite being a common law country, has a
small and highly concentrated capital market (Khwaja & Mian, 2005). Furthermore, it is characterised by weak law enforcement, lack
of transparency and fairness in disclosure, shallow equity market with high turnover and volatility, prevalence of family owned
business groups, strong corporate-political connections and corporations in Pakistan heavily rely on bank financing instead of equity
financing (Ashraf & Ghani, 2005; Iqbal, 2012; Islam, 2004; Muttakin et al., 2014; Rabelo & Vasconcelos, 2002). However, it is
following an Anglo-American code of corporate governance. Therefore, the study of agency problems in Pakistani context provided
insights into the existence of agency relationships in this unique context and effectiveness of Anglo-American governance me-
chanisms therein.
The Securities and Exchange Commission of Pakistan (SECP) is the primary regulator of non-financial corporate sector in
Pakistan. Under the influence of international funding bodies such as Asian Development Bank and the International Monetary Fund,
SECP introduced the Code of Corporate Governance in Pakistan in 2002 and it was also made a part of listing regulations in Pakistan
(Ashraf & Ghani, 2005; Iqbal, 2012). Compliance with mandatory provisions of the Code of Corporate Governance is compulsory for
listed companies. A checklist outlining the enforcement status of the clauses of the Code is provided as an appendix to the Code.
Therefore, all the provisions of the Code are marked as either mandatory or voluntary. The Code is a ‘comply or explain’ document.
Initially, the business community in Pakistan had resisted the implementation of the Code of Corporate Governance in Pakistan (The
World Bank, 2005).

3. Rethinking agency theory

We begin our discussion with the argument that developing countries do not exhibit agency problems between owners and
managers as proposed by classical agency perspective. However, these countries do present a nexus of agency problem termed as
principal-principal conflict (Dharwadkar et al., 2000; La Porta et al., 1999; Lau, 2010; Young et al., 2008). As mentioned in previous
section, Pakistan, like many other developing countries is characterised by high levels of ownership concentration and strong family
control (Gilson, 2007). In such a context, managers represent majority shareholders interests and in most of the cases, decision
making and management roles are held by the same individuals, that is, the controlling members (Lau, 2010; Li & Qian, 2013). Since
markets in these countries have high levels of ownership concentration, owing to weak legal institutions and external governance
mechanisms, it also becomes easier for controlling shareholders to expropriate the rights of minority shareholders (Abdullah et al.,
2015; Fan & Wong, 2002; Li and Qian, 2013; Razzaque, Ali, & Mather, 2016). Thus agency problem in developing countries, such as
Pakistan, exists between minority and majority owners. Principal-principal problem also shares the assumptions of self-interest and
opportunism with classical agency theory.

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We recognise the usefulness of the principal-principal model in explaining the nature of agency conflict in developing countries
(Dharwadkar et al., 2000). However, since this model is also based on the assumptions of self-interest, bounded rationality and risk
aversion as presented in classical agency theory (Eisenhardt, 1989) and proposes the same mechanisms of incentive alignment and
monitoring of executive management by non-executive directors, we begin our discussion with an analysis of the usefulness of these
assumptions in the context of Pakistan.

3.1. The assumption of risk aversion

According to the traditional agency model, agents/managers are more risk averse than principals because of limited employment
options and a lower incentive to make additional efforts, while investors/principals are interested in investing int diverse and
efficient avenues (Eisenhardt, 1989; Foss & Stea, 2014; Sauner-Leroy, 2004). Principals can make financial investments in diverse
options, while agents cannot always diversify their investment options (Faccio et al., 2011; Wiseman et al., 2012). Existing literature
argues that in markets accompanied by high level of ownership concentration, controlling owners and large shareholders in family
firms tend to be highly risk averse (González et al., 2013; Zhang, 1998) as they are exposed to both the systematic and unsystematic
risk of the firm while minority shareholders face no systematic risk (Zhang, 1998) and are therefore, less risk averse.
Nonetheless, we contend that although there is plenty of research on the nature and prevalence of controlling shareholders,
existing literature has largely ignored to explore the identity of minority shareholders. More specifically, there is a scarcity of
research on the level of financial literacy and the level of personal wealth of minority shareholders in relation to the level of overall
wealth in an economy. We contend that these factors will have a direct influence on the diversity of minority shareholder’s in-
vestment decisions. We challenge the assumption that minority shareholders have well diversified investment portfolios and have
high preference for risk based on the premise that in most of the developing countries, minority shareholders might be very small
investors. Since these countries are economically deprived, more than often, these investors might have a small amount of spare
money to invest. Small investors also face the obstacles of various entry barriers such as lack of information/literacy about markets
(Reardon et al., 2008) and lack of exit options (Leeds & Sunderland, 2005).
Since the level of literacy in developing countries such as Pakistan is very low, that is 58% (Pakistan Economic Survey, 2018),
limited information about investment options and a lack of financial and technical literacy may further reduce the capability of
investors to diversify their investment options (Xu & Zia, 2012). Thus, these investors might not be interested in making investments
in high risk ventures, as assumed by traditional agency perspective. Financial literature recognises that financially literate individuals
are more prone to make investments in stock market (Christelis, Jappelli, & Padula, 2010; Lusardi & Mitchell, 2014; Van Rooij,
Lusardi, & Alessie, 2011). While we call for more empirical research in this area, we argue that minority shareholders in such an
institutional context might also be as risk-averse as the controlling shareholders. Thus, the assumption of risk aversion in traditional
agency theory is very simplistic. We propose that there are no differences in risk preferences of principle and agent in developing
countries.

3.2. The assumption of self –interest

Classical agency theory assumes human beings to be self-interested and opportunistic. Self-interested managers will involve in
rent seeking and fraudulent behaviour or may exhibit such behaviours as shirking and lack of responsibility (Eisenhardt, 1989). This
assumption of human self-interest had deep influence on development of the policy and practice while corporate governance reg-
ulations thoroughly focused on introducing appropriate remuneration packages and monitoring of managers for controlling such
opportunistic behaviour (Feldman & Montgomery, 2015; Tosi & Gomez-Mejia, 1989; Tosi, Katz, & Gomez-Mejía, 1997). The as-
sumption of self-interest has been challenged by a number of management and organisational researchers on the ground that as-
sumption of self-interest teaches and encourages managers to behave in self-interested manner (Davis, Schoorman, & Donaldson,
1997; Ghoshal, 2005). The assumption of self-interest in classical agency model has been criticised by several researchers who argue
that human beings may also act selflessly as they expect rewards in afterlife, or for gaining social acceptance and appreciation (Fehr &
Falk, 2002; Hendry, 2005). Thus the behaviour of senior managers in corporate organisations might not only be driven by extrinsic/
monetary rewards rather, success of organisation might be psychologically more rewarding for them. Self-interest of majority owners
is also considered to manifest itself in the form of entrenchment in developing countries (Dharwadkar et al., 2000; Gilson, 2007).
We argue that in developing countries such as Pakistan, with high levels of political corruption and entrenchment (Easterly, 2001;
Transparency International Corruption Perception Index, 2016) an assumption of managerial selflessness might not hold true. In
addition, since the rule of law is weak (Javid & Iqbal, 2008), legal institutions are largely unable to contain manifestation of self-
interest in the form of minority shareholder expropriation in such a context. Thus, in alignment with traditional agency perspective,
we propose that managers in such a context will be self-interested and opportunistic.

3.3. Mechanisms for controlling agent’s behaviour

Appropriate remuneration packages and monitoring of executive management are considered to be the internal governance
mechanisms for aligning risk preferences and interests of principals and agents in traditional internal governance of the firms
(Feldman & Montgomery, 2015; Tosi & Gomez-Mejia, 1989; Tosi et al., 1997).

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3.3.1. Remuneration
In highly concentrated capital markets having family firms, explicit compensation contracts are either completely non-existent, or
even if they are drafted, remuneration is not typically linked to firm performance (Kole, 1997). Some researchers argue that
shareholders in such markets accept lower level of compensation because family ties ensure employment security (Allen & Panian,
1982; Gomez-Mejia, Larraza-Kintana, & Makri, 2003; Kets de Vries, 1993). We look at another alternative explanation which might
be derived from the literature focusing on entrenchment and tunnelling. This literature suggests that in countries with weak gov-
ernance contexts and high levels of corruption, the nature of remuneration package becomes an ineffective governance mechanism
owing to higher opportunities for entrenchment (Morck et al., 1988; Wang & Xiao, 2011). Instead of drawing upon formal re-
muneration packages, family owners rather steal resources from their companies through such self-dealing transactions as sale of
corporate assets to other controlling shareholder owned companies at low prices.
Unskillfulness and incompetence of the family members might provide another explanation for why the executives in these firms
accept lower or no compensation (Schulze et al., 2001). Eisenhardt (1989) proposed that managerial opportunism might manifest in
the form of moral hazard and adverse selection. As explained earlier, owner managers expropriate minority shareholder rights
through various forms of entrenchment. Adverse selection problem also exists in such markets as majority owners are known to hire
their incompetent family members on the board, who lack skills to run the organisation (Dharwadkar et al., 2000; Li & Qian, 2013).
Thus, we contend that remuneration contract is not an appropriate mechanism for resolving agency conflict in developing countries,
such as Pakistan.

3.3.2. Monitoring
Moving forward from our assumption that owner managers in such high expropriation countries as Pakistan are all powerful to
devise their own remuneration packages for themselves and devising appropriate compensation contract might not assist in dealing
with managerial opportunism, monitoring of executive management through independent directors may seem to be the only option
for handling managerial self-dealing (Liu et al., 2015; Yekini et al., 2015). Roberts, Mcnulty, and Stiles, (2005) explained that
interplay between executive management and independent non-executive directors enhance the efficacy of accountability in the
boardroom and thus reduce agency conflict. Hendry (2005) also emphasised on the role of non-executive directors for creation of
effective boards. Corporate Governance reforms also focus on the role of non-executive directors in controlling executive directors’
behaviour (Dalton, 2005). Now we assess the role of monitoring from NED’s as a tool for effective governance in developing countries
such as Pakistan.
Existing research argues that in highly concentrated capital markets with family firms, a lack of separation between ownership
and control alleviates the need for appointing independent directors (Klein et al., 2005). Independent directors may also lack in-
dependence owing to several factors such as obedience and loyalty to CEO (Morck, 2004), sympathy towards firm and poor director
performance prior to appointment (Cohen, Frazzini, & Malloy, 2012), and co-option and capturing by CEO (Coles, Daniel, & Naveen,
2014). Owing to a strong presence of social ties and networking, independent directors, in the context of developing countries, may
also partner with owner managers and thus may not get any platform for exercising their independence (Su et al., 2007). Further-
more, since independent directors are dependent on owner managers for information so as to control managerial opportunism
(Hendry, 2005), they may find it hard to access such information in highly concentrated capital markets with strong family control.
Thus, we argue that the mechanism of board independence might be ineffective in the context of developing countries with high level
of ownership concentration and family control (Abdullah et al., 2011) such as Pakistan.

4. Research design and methodology

We utilised a qualitative/interpretivist approach for this research and conducted 26 semi-structured interviews, which allowed
asking a series of open-ended questions from research participants (Kvale & Brinkmann, 2009). The use of semi-structured interviews
provided flexibility in the order and sequencing of questions (Bryman, 2015). The use of semi structured interviews provided the
benefits of two-way communication, enabled to seek in-depth explanations in response to probing questions, and resolved the
common problem of lower response rate associated with survey questionnaires (Flick, 2014). Hence, semi-structured interviews
allowed for the collection of in-depth qualitative data (Easterby-Smith, Thorpe, & Jackson, 2012). We used this approach as it is
consistent with the methods used in previous studies focusing on development of agency theory, while utilising in-depth interviews
(Hendry, 2005; Roberts et al., 2005). All the interviews were conducted by one of the researchers over a period of two months. Each
interview lasted for duration of one hour on average. The initial interview guide was sent to two experts in the field of corporate
governance in Pakistan and their advice was sought on the suitability of questions, considering the prevailing institutional context in
Pakistan. The interview guide was then further refined after obtaining their feedback, as it proved to be very useful in improving the
interview guide (Please refer to Appendix A for interview guide).
A judgement sampling technique (Marshall, 1996) was used and participants were identified and selected so as to provide rich
information that would help in the development of a deep insight into the nature of agency conflict in Pakistani firms. The use of
judgement sampling technique enabled the selection of such participants who were in a position to provide the most productive
insights into the nature of agency conflict in Pakistan, either because of their prior experiences or their subject knowledge and
expertise. The desire to collect broad and rich data demanded collection of data from wider stakeholder groups (Nakpodia &
Adegbite, 2018). Therefore, interviews for this research were conducted with representatives from listed companies, statutory audit
firms and regulatory bodies in Pakistan. The in-depth interviews with the Directors/CEO’s/CFO’s/company secretaries of listed
companies enabled us to understand the first-hand perspectives of family owners in family firms regarding agency conflict. The

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respondents from regulatory bodies were Chief Operating Officers/Chief Executive Officers/Joint Directors in key regulatory in-
stitutions in Pakistan. These regulatory institutions include Stock Exchanges and Securities and Exchange Commission of Pakistan.
These respondents were directly involved in the development of corporate governance regulations and the enforcement of listing
regulations and the Companies Ordinance (1984). All the respondents from the statutory audit firms were partners in those firms. The
interviews from the partners of audit firms enabled us to understand the perspective regarding the current corporate governance
context as well as governance practices of listed companies and explained how family owners take advantage of minority share-
holders for maximising their own benefits. All of the respondents had extensive experience of working in the corporate sector.
The process of interview data collection started with the generation of access to the interview participants. All the interviews were
scheduled through e-mail and telephonic communication. An information sheet, along with the consent form, was provided to all
participants. The information sheet stated the purpose of the research and assured the anonymity of the participant’s name and the
confidentiality of data. It was explained that the research did not involve any foreseeable risks to the potential participants.
Permission was sought for digital audio recording of the interviews and signed copies of consent forms were obtained from the
participants. Interviews were conducted at the business premises of the participants. As the participants were senior managers, all of
them were allocated separate rooms within the business premises, which helped in obtaining a clear and good quality recording. It
also allowed the participants to talk freely and confidentially.
Collection of data from an appropriate sample size is imperative for successful achievement of research objectives (Marshall,
Cardon, Poddar, & Fontenot, 2013). The concept of data saturation guides qualitative researchers while collecting interview data.
This concept guides primarily on when it is appropriate to stop collecting further data. Data saturation entails interviewing new
participants until dataset completes, as will be indicated by replication and repetition in the responses of new participants (Bowen,
2008; Miles & Huberman, 1994). Thus, the researcher continued collecting data till we were satisfied of having developed an
understanding of the phenomenon under research sufficiently well, so as to enable them to create knowledge (Nakpodia & Adegbite,
2018). Table 1 demonstrates that a total of 26 interviews were conducted before we concluded on having reached the point of
saturation including 6 interviews from partners of audit firms (designated as ‘P’), 5 interviews from representatives of regulatory
bodies (noted as ‘R’), 3 interviews from Company Secretaries and 12 interviews from CEO’s/Directors/CFO’s of listed companies
(jointly labelled as ‘C’).
Template analysis was used for the analysis of interview transcripts whereby a template was developed containing a list of
categories derived from data, after performing a thematic analysis on data (Saunders, Lewis, & Thornhill, 2012). Qualitative data
analyses software (NVivo) was used to assist in the process of data analyses. Categorisation was the first stage in data analyses
process. This stage involved the identification of the ‘categories’ from interview transcripts. The groups of data were labelled using
these categories in order to provide a structure for further analyses. The arrangement of these categories was directed by the the-
oretical propositions of the research project. Second stage of data analyses stage was termed as ‘unitising’. This stage involved the
allocation of relevant portions of transcripts under each of the categories/nodes. The identified sections of data were allocated to the
relevant nodes. This approach helped to organise data in a manner so that the resulting display of data would provide a better
understanding regarding the phenomena researched. In the third stage of data analyses, relationships between various categories
were identified. Various themes emerging from the data were analysed and re-analysed and their allocation to various categories
changed as the process of analyses continued. Some of the previously identified categories were eliminated, while some new cate-
gories also emerged as the analysis progressed. Meaningful relationships between categories were established so as to obtain the
answers to the research questions. Lastly, the analyses of the research data provided insights into the initially developed research
propositions. Alternative explanations for various relationships were sought. These alternative explanations to the research problem
were helpful in enabling us to reach useful findings regarding researched phenomena.

5. Discussion

5.1. Risk aversion

We started analyses by looking at how well the assumption of risk aversion explains the context of Pakistani capital market. We
found that the owner managers (controlling shareholders) have limited investment options in Pakistan and are risk averse owing to
weak governance institutions prevailing in the country (Dharwadkar et al., 2000). Government is also known to create obstacles in
development of firms in Pakistan, which is consistent with the findings from existing literature on developing countries (Brush, Ceru,
& Blackburn, 2009). 3 partners from the audit firms and 6 CEOs/Chairmen/CFOs from the listed companies explicitly expressed their
concerns about poor property rights and explained the risks associated with making investments in the country. However, we also

Table 1
Profile of the Research Participants.
Position held Number Percentage

Partners in Audit Firms 6 23%

Representatives of regulatory bodies 5 19%
Company Secretaries of listed companies 3 12%
CEO’s/Directors/CFO’s of listed companies 12 46%

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F. Yusuf et al. Accounting Forum xxx (xxxx) xxx–xxx

found that owner managers are quite confident of their capabilities to expand and diversify their investments and consider gov-
ernment to be responsible for them to feel unprotected. Weak investor protection brings uncertainty and fear of absolute loss which
serves as a reason for non-diversification and expansion of their business and investment.
“If any of the group (of companies) grows in size… if any group sets up 4 companies here, then instead of going for 5th company
in Pakistan, it will invest abroad. If someone wants to start 5th company then he will not get it registered over here but in some
other country. If someone will own many companies, the government will nationalize it. The worst era was that in 1971 na-
tionalization and even in 1988, when Benazir came, she started arresting people. When Nawaz Sharif came, he started fighting
against the policies of Benazir…you know Itifaq Foundries…if it was not nationalized, then now they might have been manu-
facturing huge planes over here, it had a huge capacity. They (government) did not let them grow” (C10 – CFO, Listed Company).
For majority shareholders, a lack of trust on the system and government’s (invisible) cap on the amount of investment injected by
a company in Pakistani economy, limits investment options. However, we challenge the assumption that minority shareholders in the
environments accompanying weak legal institutional and poor investor protection are less risk averse than controlling owners, or
they bear no systematic risk. We argue that minority shareholders face a considerably higher risk while they make an investment
decision as their rights are largely unprotected (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000). We found that minority
shareholders face an even more intense problem in finding enough ‘trustworthy’ investment options.
“Minority shareholders are not interested in buying shares anymore. If there is a continuous loss and companies cannot run
profitably…the private shareholder or minority shareholders will not agree to take part in business, so people are losing interest.
There is a loss of trust by the general public. If I will not enjoy the profit why will I invest in a business?” (P5 – Partner, Audit
Firm).
“Situation is not good. In simple words, minority shareholders are in poor situation. Because minority shareholders…you know in
Pakistan there are many things which are written in the books but nothing is done in practice. Minority shareholders…normally,
family owners do not even invite them in the AGM” (P6 – Partner, Audit Firm).
In order to develop a deep understanding on availability of investment options to minority shareholders, we analysed the pattern
of growth of the Stock Market in the country. In the 1980s, the Government of Pakistan revisited its nationalisation policy and
introduced a disinvestment programme of government-held shares whereby private businesses were encouraged to make investments
in the financial system through investment banks. In the 1990s, the government initiated a move towards privatisation, coupled with
increased encouragement for private sector investors (Iqbal, 2012). The resulting progress of the equity market can be summarised by
the fact that while the number of listed companies on the Karachi Stock Market in 1949 was five, it reached to 762 in 2000. However,
this number started declining afterwards. In 2016, Karachi Stock Exchange (KSE) was merged with two other stock exchanges in the
country, that is, Lahore Stock Exchange and Islamabad Stock Exchange and was renamed as Pakistan Stock Exchange. The current
number of companies listed on Pakistan Stock Exchange is 576. We discussed the reasons for the fall in the number of listed com-
panies on Pakistan Stock Exchange with our research participants. We found that since the establishment of Pakistan, most of the
businesses in the country had been family owned. In order to promote corporate culture in the country and to strengthen its stock
exchanges, the government offered tax rebates to listed companies. Therefore, in order to take advantage of the tax benefit, family
businesses listed themselves on stock exchanges. However, with the passage of time, the government has eliminated the subject tax
relief. Therefore, listed companies have been left with very small tax incentives, while they have to comply with corporate gov-
ernance regulations - compliance with which is very expensive (Hamid & Kozhich, 2007). As they do not receive any benefits, listed
companies are therefore becoming delisted from stock exchange. One respondent from a listed company explained:
“The government announced a benefit that was tax rebate…most of the businesses were actually family oriented businesses…they
wanted to maintain their family structure in the same way…but they wanted to take benefit out if it. However, over the period of
time that tax benefit is also eliminated. If you see in the previous five to six years, how many companies have been listed in the
stock exchange? Their perspective is that there is no tax benefit anymore…people think that listing is of no use” (C9 – CEO/
Chairman, Listed Company).
This evidence raises questions about the effectiveness of stock market in developing countries such as Pakistan (Iqbal, 2012) and
strengthens the notion that capital markets in Pakistan and other emerging economies do not play a substantial role in raising capital
for corporations (Khwaja & Mian, 2005), whereby, bank financing remains their first preference. Since controlling shareholders do
not primarily depend on equity financing, minority shareholders never receive due attention and are deprived of their rights. The
majority owners in developing countries like Pakistan do not also offer corporate shares to public for diversification of risk (Zhang,
1998) for raising equity capital. In reality, most of the companies had got themselves listed on stock exchange for getting tax rebate.
When in need of capital, these firms still approach for bank finance, instead of issuance of new shares. CEO of another company
stated:
“We had floated shares only for once and it was when we had incorporated the company…it was about 10 or 12 years back. So we
did not do public offering after that as we did not need equity” (C1 – CEO, Listed Company).
When we closely observed the institutional environment in the country, we concluded that controlling owners hold enormous
powers in comparison to minority shareholders. For example, the controlling owners may decide to delist the company in exchange of
a small value for the shares of minority shareholders. A respondent explained:

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F. Yusuf et al. Accounting Forum xxx (xxxx) xxx–xxx

“They are family owned companies, and they will definitely not wish to hire the non-executive director on their board. So, they
will prefer to go for delisting. So, they offload 25% shares from their own pockets or from banks and just get rid of the minority
shareholders. They will…request SECP to determine the market price based on their book value…so, may be getting back their
shares at below par value….and it shows that the legal protection to minority shareholders does not practically exist” (C2 –
Company Secretary, Listed Company).
Rate of literacy in Pakistan being only 58% (Pakistan Economic Survey, 2018), level of literacy in general and the level of
financial literacy prevailing in the country in particular are other important factors limiting investment options for minority
shareholders.
“Most of the minority shareholders are illiterate. They do not even read what the director’s report says, what are they (directors)
planning, what is lacking in the reporting process…” (P2 – Partner, Audit Firm).
As a consequence of low levels of literacy, shareholders have a very limited access to information about various investment
options. Their inability to understand financial and technical information further reduces the ability of minority shareholders to
diversify their investment options (Xu & Zia, 2012). Lack of literacy and appropriate information hampers their capacity to make
investments in high risk ventures, as suggested by agency theory.
We understand that these findings are not surprising as the problem of expropriation of minority shareholders in developing
countries is well recognised by existing literature (Cesari, 2012; La Porta et al., 1999; Razzaque et al., 2016). We contend that risk
taking or risk aversion behaviour is largely conditioned by institutional context, and will also get affected by individual’s personal
risk preferences in either of the roles (Cuevas-Rodríguez et al., 2012; Kahneman & Tversky, 1979). However, agency theory as-
sumption of managers/agents being more risk averse than principals does not seem to hold in the institutional settings of Pakistani
capital market.

5.2. Remuneration

We found that remuneration contract is not appropriate in aligning interests of principals and managers in Pakistan, as the CEO/
Chairmen and executive directors in many companies do not draw any remuneration from the companies.
“In my board for the last 15 years, or 18 years, nobody was taking anything because the company’s financial health was not very
good” (C5 – CEO/Chairman, Listed Company).
One possible explanation for not drawing any remuneration from the firm might be derived from the literature stressing to
incorporate the assumption of selflessness in agency relationships (Hendry, 2005). Thus, directors in such firms might be acting
selflessly and thus they do not draw monetary benefits as they expect rewards in the form of gaining social acceptance and appre-
ciation. However, we do not find any evidence in support of this standpoint as all the directors talked about their own benefits, their
owned firms and their personal ownership in the firms. Our analysis suggests that in the context of Pakistan, CEO/Chairman and
other family members consider the companies to be their personal ownership. A larger stake in the firm definitely entitles them to
better rights in decision making, access to information, and control in organisation. Accordingly, organisational decisions are made to
maximise their personal/family monetary benefits and not those of minority shareholders. The owner managers/directors introduced
a clear distinction between themselves and minority shareholders when they talked about investors’ rights. Since these owner/
managers often belong to influential and wealthy families in the country, their privilege speaks for them:
“Obviously, a person has invested everything he owned into business and he owns the majority shareholding in the company, and
he is managing the company. He has his directors in the board of directors. They are managing the company. If we talk about a
person who has 1% shareholding or who has only one share of the company, how can we consider that person as the owner of the
company?” (C11 – Director, Listed Company).
Our evidence also suggested that majority owners do not draw remuneration from the firms, rather, they extract monetary
benefits from the firms through enhancement. For example, they may expropriate minority shareholder rights through transfer of
firm’s assets at below market value, and nepotism (Li & Qian, 2013). Partners of audit firms confirmed existence of entrenchment in
their interviews:
“I had seen in a company…there was no company policy about the number of years a car was to be depreciated and sold out and it
was not mentioned that the depreciated cars could not be sold out to the employees or related parties…but they were actually
selling cars to the employees and related parties….there was no proper procedure for bidding” (P6 – Partner, Audit Firm).
We contend that human behaviour is conditioned by institutional environment (Lubatkin et al., 2007) and while in certain
contexts, humans might display self-interested behaviour as their institutional context allows them to display such behaviour without
reprimand, in other contexts, display of such behaviours might be totally restricted. We do not disregard Hendry (2005) proposition
that managers might not always act in self-interested manner and might be selfless, however, we did not find this to be true in the
context of Pakistan. It is imperative to note that according to the Transparency International Corruption Perception Index (2016),
Pakistan was positioned at 116 from a total of 176 countries, which points to a high level of corruption in the country. We contend
that looking for selflessness in corporate affairs in such high expropriation environments seems to be rather unrealistic. As explained
previously, exploiting organisational resources through entrenchment provides evidence of strong self-interest in the context of this

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F. Yusuf et al. Accounting Forum xxx (xxxx) xxx–xxx

country. We conclude that in a country such as Pakistan, where institutional environment allows for corruption and entrenchment to
prevail, formation of formal remuneration contracts does not serve as an appropriate governance mechanism.

5.3. Monitoring

Moving forward from our conclusion that manager owners in such high expropriation countries as Pakistan are all powerful to
devise their own remuneration packages for themselves and devising appropriate compensation contract might not assist in dealing
with managerial opportunism, monitoring of executive management may seem to be the only option for handling managerial self-
dealing (Liu et al., 2015).
We found that in the boardroom of majority of the listed companies, hiring of an independent director is not an easy task. Rather,
the concept of an independent non-executive director is not only novice, it is rather unwelcomed. As majority of the companies listed
in stock exchanges are family owned and controlled, the family owners resist inclusion of independent non-executive directors on the
board. Having non-executives on the board implies a loss of their control on corporate affairs and decision making. As they are the
actual owners of the company they do not want non-executives to monitor their activities. Furthermore, appointment of non-ex-
ecutive directors increases cost - another factor to discourage such an appointment. The CEO of a family firm stated:
“In Pakistan, 80% or 90% of the businesses are family owned, and you have a requirement like non-executive directors or outside
directors. This really does not make sense. You know if an entrepreneur is setting up an industry with huge investment, so how can
he accept that a non-executive director becomes the part of his board? He (non-executive) buys only 500 shares and sits next to
him on the board. If you start a business with your own assets, wealth, stake, cash flow or pocket, so how can you bear that
instantly somebody come from outside and sits equivalent to you, challenges your decisions or disagree with them? Because the
entire stake is yours, so how can you wish that someone comes from outside and influences your decisions?” (C1 – CEO, Listed
Company)
Board independence is quite often considered as a symbol of board effectiveness and therefore, regulatory bodies in Pakistan are
encouraging listed companies for independent boards (Boivie, Bednar, Aguilera, & Andrus, 2016) while the Code of Corporate
Governance 2012 requires that the listed companies must have at least one independent director on the board. However, regulators
accept that despite introduction of regulations, compliance with the regulations is not more than a tick box activity. The Chief
Operating Officer of one of the stock exchanges explained the challenges faced by regulatory bodies in implementation of corporate
governance reforms. He stated:
“We can’t find independent director in true sense…companies give such a high remuneration to him for his services, like only for
attending the board meeting or for attending any other meeting. So it defeats the spirit… after some time the independent director
become dependent over the company, and he starts speaking the language of management. He uses the words that management
provides him so independence can’t be assured at any time” (R1 – Chief Operating Officer, Stock Exchange).
This evidence raises questions about the effectiveness of having independent directors on board. Mcnulty, Zattoni, and Douglas,
(2013) argued that effectiveness of the board depends on the management of tensions by the chairman and the non-executive board
members. This view does not seem to work well in the context of Pakistan where CEO and Chairman positions in majority of the listed
companies is held by the same individual. As the respondents from this research point out, non-executives do not have any role to
play in the prevailing governance set-up in the companies. An executive director explained the role of the non-executive directors in
the following words:
“Those directors totally work as dummy directors. That director is coming and claiming travelling expenses, entertainment and his
fees. But he is not contributing anything by and large. So they just want to enjoy remuneration by and large and their contribution
is almost nil” (C7 – Director, Listed Company).
Existing literature recognises that the independent directors may lack independence owing to several factors such as obedience
and loyalty to CEO (Morck, 2004), sympathy towards firm and poor performance prior to appointment (Cohen et al., 2012), and co-
option and capturing by CEO (Coles et al., 2014). We found that the majority of the boards in Pakistan’s context are either not
independent or are ineffective. However, we revisit our understanding about board effectiveness. According to Mcnulty et al. (2013),
board effectiveness entails good conduct of corporate affairs, effective strategy formulation, good quality corporate reporting and risk
management, appropriate incentives and fair HR policies. Considering the context of Pakistan, more than 50% of the listed companies
are family owned and controlled (Ashraf & Ghani, 2005). Most of these companies are successfully running the business for several
generations. These family businesses do not welcome inclusion of non-executive directors on the board and strongly believe that they
are performing well in terms of financial performance. They claim that their boards are effective. They argue that they are capable of
taking best decisions in the interest of the company and are doing their job successfully. Thus, they do not find any reason to
introduce non-executive or independent directors to control them. The chairman of a family owned and controlled family firm
asserted:
“If you will look at the world’s successful corporate ventures, there has always been somebody who is the founder and later on
(they are) controlled by the families. It is same all over the world. People have huge stakes but they do not ever make public
companies. They are running private limited companies. Beretta makes revolvers. It is considered that they make the most reliable
revolvers in the world. Even American army uses their revolvers and guns. They are an Italian family. They have one

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F. Yusuf et al. Accounting Forum xxx (xxxx) xxx–xxx

manufacturing facility in Italy and other in the US. It is privately owned company. They are running is as a family business. Their
brand is established all over the world” (C9 – CEO/Chairman, Listed Company).
While family members, in their role of directors might be working in the best interest of the majority shareholders, these con-
trolling shareholders do not consider a very small number of minority shareholders having small investments significant. They, in
their own right, constitute an ‘effective’ board.

6. Conclusion

We focused on investigating if agency theory provides an appropriate lens for explaining corporate governance in the context of a
developing country, that is, Pakistan. We further examined whether internal mechanisms of remuneration and monitoring work
effectively in resolving agency conflict in Pakistani context. Through an in-depth investigation utilising 26 semi-structured inter-
views, we found that in Pakistan, principals (minority shareholders) and agents (majority shareholders) both have restrained in-
vestment options and there will be no variation in the risk appetite of majority and minority shareholders. We argue that existing
models and reforms for governance are effective and provide useful explanations in the capital markets having a large and diverse
base of minority shareholders. However, in the context of developing countries such as Pakistan, we found that the minority
shareholders exist in such small numbers that they are almost unrecognised. Even the regulatory bodies recognise that the controlling
members of the board are the actual owners of the business and work in the best interest of the firm, while minority shareholders do
not have the right to question or complain against them. From an agency perspective, the analysis of this data shows a grave picture
of minority shareholder rights in Pakistan. Family owners appear to be highly self-interested and opportunistic so the propositions
that board of directors might be selfless do not hold true in such contexts with high levels of expropriation and corruptions. Our
analysis suggests that remuneration packages are not an effective tool for governing owner managers in such an environment.
Furthermore, controlling managerial executive opportunism through board independence in such a context can prove nothing more
than a false hope. Creation of accountability in boardroom and protection of minority shareholder rights thus remains a big challenge
in the context of developing countries.
We propose that in order to ensure effective governance in the context of developing countries such as Pakistan, policy makers
must shift their focus from soft internal governance mechanisms such as appropriate remuneration and monitoring by independent
directors. Monitoring by independent directors, in such a context, cannot replace the need for strict regulation. Since independence of
non-executive directors can be easily compromised in family owned and controlled firms, regulators might appoint non-executive
directors on the boards of these companies. In order to ensure independence of audit function, we recommend that the appointment
of audit firms should be made by the regulators, instead of the firms choosing their auditors. We also propose for development and
strict implementation of regulation regarding minority shareholders rights. We argue that since the listed companies in such en-
vironments list on stock market for getting benefits, they must also be educated about their responsibilities in this regard. Provision of
various training programmes might also assist existing family owners about their responsibilities towards minority shareholders.
We also call for more in-depth research focusing on agency problem in the context of Pakistan and other developing countries.
Although the study of principal-principal conflict was the focus of this study, we also recommend for a close examination of agency
relationship between controlling owners and management team in the context of developing countries with high levels of family
ownership and highly concentrated capital markets. We also call for more research on risk behaviours of majority and minority
shareholders in developing countries. Study of how financial literacy of investors affects their investment decisions and subsequent
agency relationshipsis also an unexplored area yet.

Appendix A

Interview Guide

1 What is your opinion about the current state of corporate governance in Pakistan?
2 What, in your opinion, are the main problems confronting corporate governance in the country?
3 What were the objectives for the introduction of corporate governance disclosure regulations for listed companies of Pakistan?
4 Do you consider the existing corporate governance code as an effective document for resolving corporate governance problems in
the capital market of Pakistan?
5 Who controls the management of a listed company?
6 Do you consider board independence as an effective mechanism for monitoring and control?
7 How are the interests of the owners of the business protected?
8 Are current corporate disclosure practices catering for minority shareholders’ interest?
9 How protected are minority shareholders?
10 Are you satisfied with the quality of corporate governance compliance by the listed companies in Pakistan?
11 Can the imposition of more stringent regulation improve the quality of corporate governance in the country?
12 Can you quote any incidents (without name) when the regulatory body prosecuted or took action against directors, chief ex-
ecutive or other officers for non-compliance with the code of corporate governance?

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